The average American's retirement savings remains anemic, wages are only inching higher, and employers continue to abandon pension plans. So, it's little wonder that more Americans are taking Social Security early and continuing to work.
Punching a clock while you're collecting Social Security can provide additional financial security, but you should remember that if you're younger than your full retirement age, the Social Security Administration will reduce the amount you receive in Social Security income if you earn over a set income limit. In 2017, that limit will increase to $16,920 from $15,720 in 2016.
How does Social Security's income limit work?
The $16,920 income limit is only applied to individuals who are younger than their full retirement age. Your full retirement age, or the age at which you qualify for 100% of your Social Security benefit, depends on the year in which you were born. Currently, the full retirement age is 66. However, it increases to 66 and 2 months next year. Eventually, the full retirement age climbs to age 67 for people who were born after 1960.
When you claim Social Security before reaching your full retirement age, you qualify for a reduced Social Security benefit. For example, if your full retirement age is 66 and you claimed Social Security at age 62, then you're receiving about 75% of the amount you would've received if you had waited until your full retirement age to enroll.
If you're younger than full retirement age, continuing to work, and will earn more than $16,920 next year, then Social Security will further reduce the amount you receive in Social Security income by $1 for every $2 dollars you earn above next year's income limit.
For example, Joe is a 62-year-old who took Social Security early and who continues to work. Joe's full retirement age benefit would have been $1,000 per month, but since he took Social Security at age 62, he receives $750 per month.
Assuming Joe expects to earn $20,000 in 2017, he will be $3,080 over next year's earnings limit. Since Social Security reduces payments by half the amount earned above the income limit, Joe's Social Security income next year will be $1,540 lower ($3,080/2) than if he had earned less than $16,920 in 2017. Thus, Joe will receive a total of $7,460 in Social Security income next year, instead of the $9,000 he would've received otherwise.
This reduction in Social Security payments won't be spread out equally across Joe's monthly Social Security payments. Instead, Social Security will withhold Joe's first three monthly payments, or $2,250. Joe will receive his remaining nine months of payments at his full amount of $750.
In Joe's case, withholding the third month means that Social Security has held back too much money. Instead of holding back $1,540, Social Security has held back $2,250, or $710 too much. This "overpayment" will be returned to Joe in 2018.
What happens to money that's withheld by Social Security?
If your monthly Social Security payment gets reduced because you're going to earn over the income limit next year, don't worry. You'll get that money back. Any money that the Social Security Administration withholds because of the income limit is added back to your benefit calculation so that when you turn your full retirement age, you get a higher payment than you'd get otherwise.
Because of this, retirees who would like to receive some Social Security now but would also like a bigger payment later may find it beneficial to work a bit more until they reach their full retirement age. Remember, you can earn as much as you like without it reducing your Social Security payment once you attain full retirement age.
Also, the amount withheld in the year in which you reach your full retirement age is determined by a different calculation. If you reach your full retirement age in 2017, then Social Security will reduce your Social Security income by $1 for every $3 earned above $44,880, but they'll only count earnings up until the month you reach full retirement age.
Oh, and not all earnings are equal
If you have dividend income, interest, pensions, government payments, investment earnings, or capital gains, don't fret. The Social Security Administration only considers wages that you earn by working for an employer. If you're self-employed, then Social Security bases its calculation on your net earnings, not your gross earnings. You should remember, though, that Social Security will count contributions to pension or retirement plans if they're included in your gross wages.
Social Security income limits can be confusing, so if your situation is complex and you're still unsure how the income limit will impact you in 2017, contact Social Security or your tax planning professional beforehand to avoid surprises.
It's vitally important to understand the basics of this key program.